The tax extender bill has come early this year! Unlike most years where Congress waits until the last few weeks of December to roll out the bill, they are finally giving taxpayers time to plan ahead for the following year, and taxpayers are grateful.

The legislation, if passed by Congress, will extend the Research and Development Tax Credit for two years, along with the Second Generation Biofuel Producer Tax Credit, the Special Depreciation Allowance for Second Generation Biofuel Plant Property and the Controlled Foreign Corporation Look-Through Rule.

The bill would also let companies claim the R&D credit against the Alternative Minimum Tax (AMT), which has caused problems for small and medium sized businesses trying to claim the credit in the past, and it would make the R&D Tax Credit refundable for small businesses, allowing companies that are less than five years old and have less than $5 million in annual gross receipts to take a credit of up to $250,000 against payroll taxes paid on employee wages.

The Biotechnology Industry Organization (BIO) released a statement thanking the Senate Finance Committee for proposing the extension of crucial tax incentives.

“The R&D Tax Credit is a vitally important incentive that spurs private-sector investments in biotechnology companies as they search for new cures and treatments. The credit helps the biotech industry generate thousands of high paying jobs in the biotechnology sector. The R&D Tax Credit is pro-innovation, pro-growth, and pro-America, and we strongly support the provision to make a portion of the R&D Tax Credit refundable, which will improve small, pre-revenue companies’ access to the tax credit.”

If your company is conducting R&D and would like a feasibility study at no cost or if you would like to know more about the government tax incentives, please contact a Swanson Reed specialist for more information.

The circumstances for claiming R&D credits vary between C-Corps, S-Corps, and LLC’s. The overriding limitation is that credits can be claimed no further back than 3 years from the date of filing.

Within that three-year window of opportunity there must be qualifying research expenses (QRE), documentation of QRE’s and enough QRE’s to make the credit worthwhile to pursue.

C-Corporations

C-Corps are separate legal entities that pay taxes. They must have a profit that generates taxes which can  be offset by an R&D credit, so they must have reasonable hope that they’ll be profitable at some point in the near future to benefit from the credit.

If a C-Corp knows that it will be profitable soon, it should amend any of the last three years’ returns that have QRE’s and carry them forward to apply to the taxes in the profitable year.

If a C-Corp only hopes to be profitable sometime in the near future, they have two choices:

1. Amend a year within the last three years that has QRE’s and have the credit ready to defer future taxes. The credit can be carried forward for 20 years.
2. Simply maintain QRE documentation so that it can be used if taxes are incurred within the next three years.

S-Corporations and LLC’s

S-Corps and LLC’s are generally treated the same for the conditions under which they can claim an R&D credit.

Neither S-Corps or LLC’s pay taxes. They simply prepare K-1’s and pass on any benefits to their shareholders or partners/owners. Therefore, the profitability status of S-Corps and LLC’s is irrelevant.

In nearly all scenarios, the shareholders or partners benefit from an R&D credit. If the company was profitable during the year of initial filing, an R&D credit makes them more profitable. If the company was unprofitable during the year of the initial filing, an R&D credit makes them less unprofitable. Both scenarios generate a gain which will be taxed, but a percentage of anything is still more than 100% of nothing.

Shareholders and partners/owners will be impacted as individuals who will most likely realize a net benefit. Those whole file under alternative minimum tax (AMT) are more likely not to benefit from an R&D credit.

Alternative Minimum Tax (AMT)

Due to the removal of exclusions, deductions and other personal situations, AMT filers can possibly be in a taxes-due category. Consulting with the tax preparer of the AMT filer will be necessary to determine the impact of a gain from an R&D credit.

With the exception of AMT filers, S-Corps and LLC’s always benefit their shareholders and partners/owners by claiming R&D credits for years with QRE’s that can be documented within the range of amending.

 

What is the R&D Tax Credit?

A tax incentive for performing qualified research (not necessarily successful) in the U.S., resulting in a credit to a tax return.

What is the impact of the R&D tax credit?

The credits are “post-tax tables.” Therefore, R&D credits result in a dollar-for-dollar tax benefit.

Who is eligible?

Anyone who satisfies the IRS’ 4-part test and substantiates and documents their qualifying research expenses (QRE’s).

What is the IRS’ 4-Part Test?

1. Technological in nature: Mathematics, Engineering, Computer science, Earth/natural sciences
2. Improved functionality: Performance (speed), Reliability (capacity), Quality, Cost reduction
3. Eliminate uncertainty: Capability uncertainty (“Can we do it?”), Methodology uncertainty (“How do we do it?”), Product design (“What is the correct formula?”)
4. Process of experimentation: Evaluating alternatives, trial & error, scaling-models, testing results, analyze & form new hypothesis

What are Qualifying Research Expenses?

Those operating expenses of a taxpayer that form the basis of the R&D credit, which are made up of payroll, supplies and contracted research services.

Are there any industry or business organization limitations of who can claim the credit?

No, fortunately any company, large or small, from corporations to sole proprietorships in any industry can qualify for the credit.

Does my R&D project have to be successful?

No, your R&D project does not have to be successful to be eligible for the credit. By definition, much R&D will be trial-and-error and prone to failure. The intent must be genuine though and not form a pattern of manipulating data.

Is there a limit on how many QRE’s I can claim?

No, there is no limit amount of  qualifying expenses you can claim.

Can the credits be carried forward or carried back?

Yes, credits can be carried forward 20 years and back one year.

Can I claim the R&D credit for amended returns?

Yes, amended returns for up to three years back can yield additional credits.

Is there a way to maximize my credit?

Federal returns allow an additional 20% (net of calculations) credit for R&D conducted through universities. Some states offer additional credits for this well. Find out if your state is one of them.

Documentation is another way to maximize your credit. The more QRE’s that are substantiated, the more you can claim.

 

The guidelines for claiming the R&D Tax Credit vary depending on certain factors; one being your organization type. It is beneficial to be aware of the general process for filing for your company structure. Below are the basics for S-Corporations filing an R&D tax credit claim.

S-Corps Forms

• S-Corps file Form 2553 as an election of status.
• S-Corps file Form 1120S for their income tax return.
• S-Corps issue Schedule K-1’s to their shareholders.

Schedule K-1’s

When a S-Corp files an amended return, new K-1’s are issued to the shareholders. The K-1’s pass through income, losses, deductions and credits to the shareholders. The shareholders have the option of amending their personal returns with a form 1040X. The 1040X will reflect the gross credit, a tax on that credit, and it will trigger a payment to the shareholder for the net R&D credit.

In order for a shareholder to realize a benefit from an amended year, the S-Corp must have met its cut-off date for amending its 1120S and issuing K-1’s to the owners. Without the K-1’s from the S-Corp, the shareholders have no basis for amending their personal returns, regardless of their filing dates.

R&D credits are designated in Part III of the K-1. Ultimately, “flow through” incomes and credits hit the individual taxpayer’s personal return, Form 1040. The individual therefore benefits by his or her share of the R&D tax credit.

Is Amending a Return Worth It?

The R&D tax credit flow-through should be significant to justify amending a tax return. For example, a $1,000 benefit spread over 10 shareholders is only worth $100 each. Remember that amending returns authorizes the IRS to review the entire year.

S-Corps Filing Dates

• Initial filing date: 2 ½ months after the end of the fiscal year.
• Extended filing date:  6 months after the initial filing date.
• EXAMPLE:
  • Fiscal year end = December 31
  • Initial filing = December 31 + 2 ½ months = March 15
  • Extended filing = March 15 + 6 months = September 15

S-corporations file amended returns up to 3 years after the date of filing. For example, if filed on March 15, 2012 then March 15, 2015 would be the last date to file an amended return.

S-Corps and Profitability

S-Corps do not have to profitable in the year in which they want to claim an R&D credit, but they must be actively engaged with carrying on a trade or business. They cannot be merely investing in someone else’s activity or acting as a conduit.

Click here to determine your eligibility or contact a Swanson Reed specialist for more information.

Time plays an important factor in the R&D tax credit process. Tax filing dates and rules are set by law so it is important to be aware of filing dates. Filing dates determine when tax returns can be amended, which opens the possibility of claiming more R&D credits. Filing a late claim could result in a missed opportunity to receive a substantial credit.

Calendar Years vs. Fiscal Years

To better understand the filing dates for each type of business, it is important to understand the difference between a calendar year and a fiscal year. Calendar years are always from January 1st to December 31st. Fiscal years can be any consecutive 12-month period, beginning on the first day of the first month and ending on the last day of the last month. Fiscal years drive tax reporting. Taxpayers pick fiscal years different from calendar years to suit their operational purposes, so they aren’t doing taxes in a period of peak activity, like Christmas time would be for retail companies.

Fiscal years that don’t run congruent to calendar years are designated by the month in which they end. For example, a fiscal year that runs from October 1, 2012 to September 30, 2013 is called “fiscal year 2013.”

Corporations (C-Corps and S-Corps)

• Initial filing date: 2 ½ months after the end of the fiscal year.
• Extended filing date:  6 months after the initial filing date.
• EXAMPLE:
  • Fiscal year end = December 31
  • Initial filing = December 31 + 2 ½ months = March 15
  • Extended filing = March 15 + 6 months = September 15

Click here for filing dates for tax years beginning after December 31, 2015.

Limited Liability Companies (LLC’s)

LLC’s are initially treated like a sole proprietorship or partnership with an initial filing date of April 15 and an extended filing date of October 15. LLC’s can elect to change their fiscal year and be treated like a corporation for tax purposes. If this is the case, LLC’s will have the same filing dates as Corporations.

Click here for filing dates for tax years beginning after December 31, 2015.

Individuals, Sole Proprietorship and Partnerships

Individuals, sole proprietorships and partnerships have the same initial filing date of April 15 and an extended filing date of October 15. Individuals receive “flow-through” benefits from S-Corps and LLC’s.

Amended Returns

Corporations and LLC’s can file amended returns up to 3 years after the date of filing. Returns submitted on or before the initial filing date are treated by the IRS as filed on the initial filing date. Returns submitted between the initial and extended filing dates (filing under an extension), are treated by the IRS as filed on the date of submission.

Corporations use Form 1120X to amend a past return. LLC’s use Form 1065X to amend a past return.

Be aware that amending a past return allows the IRS to re-examine that entire year. According to the IRS website, “the IRS can include returns filed within the last three years in an audit. Additional years can be added if a substantial error is identified. If a substantial error is identified, the IRS will not go back more than the last six years.”

Contact a Swanson Reed specialist for further information on claiming the R&D tax credit.

The R&D tax credit continues to be a debate in Congress every year. In May, the House passed a bill to make the R&D tax credit permanent which has yet to be approved by the Senate and the White House.

According to experts at the Wharton School of Business and New York University, fundamental questions on the best approach to the tax credit, include: Should incentives encourage some kinds of research over others? Should investments simply be fully expensed when made? And, should the credits be made permanent?

Visiting Professor of business economics and public policy at Wharton and a professor at New York University, Nirupama Rao, is an advocate for the credit and says it proves to have a positive effect on the U.S. economy.

“The overwhelming evidence is that they are effective. If you make R&D cheaper for corporations, they seem to do more [of it]…a 10% decrease in the price of R&D leads to a more than 10% increase in R&D spending,” said Rao, according to Knowledge@Wharton.

While researching the impact of the R&D tax credits, Rao found that the credit saved companies between 6% and 7% of their overall tax liability.

“A 7% discount is not trivial,” said Rao. My research and research by others have shown that that is enough of a discount to get the companies to spend more. We do get some bang for our bucks when we are dishing out these tax credits.”

If Congress goes through with making the credit permanent, they should also get rid of its complexities. Neither of the current methods for calculating the credit encourage R&D, according to Rao.

The traditional credit requires qualifying companies to calculate the ratio of their total R&D spending divided by total sales between 1984 and 1988. Companies that were created after those dates or do not have documentation for those four years are entitled to a flat 3% as their base to calculate the credit. “Having a base that is based on 30 years ago is silly. It’s before the Internet, [and] before pharmaceutical innovation,” said Rao.

The other method known as the alternative simplified credit is the more popular option, which is based on a company’s R&D spending over a three year period. Rao believes this method causes companies to delay their investments “because every dollar you spend today becomes part of your base for the next three years. That undermines the credit. It leaves a lot of firms out in the cold with negative rates or low rates and we are weakening the incentive for R&D,” she said.

Her advice to lawmakers is to offer a flat tax rate of 4% on all R&D spending. “It’s simple, it doesn’t rely on data from 30 years ago and it doesn’t have that moving average base that leads to low and negative credit rates for many firms.”